May 16, 2012
The Wall Street Journal gave considerable play to a new report by Credit Suisse that warns about the condition of multi-employer pension plan. The article tells readers that the Department of Labor:
“uses an ‘actuarial’ reading of the numbers, which envisions an average (and hefty) 7.5% rate of return on investments, smoothed over five years.”
Actually, given the current price to earning ratio in the stock market, a 7.5 percent nominal return assumption is perfectly reasonable for funds that are 60-70 percent invested in stocks. (Fans of arithmetic can try playing with the numbers themselves with CEPR’s pension return calculator.)
It would have been helpful if Credit Suisse and the Wall Street Journal made similar warnings about excessive return assumptions back in the late 90s when the price to earning ratio in the stock market was crossing 30 to 1. At that time, the 7.5 percent return assumptions of pension funds really were “hefty.” In fact, they were ridiculous, but there was no interest in listening to those of us who were issuing such warnings.
[Addendum: CEPR’s pension calculator shows the future price to earnings ratios (value of all corporate equity relative to all after-tax corporate profit) under a baseline projection that assumes the same profit growth rate as the Congressional Budget Office and a 9.5 percent nominal rate of return on stocks. We allow users to vary assumptions on growth rates and rates of return to see how that would affect price to earnings ratios. Enjoy!]
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